CoStar CEO Florance cashed in on a 'financial disconnect'

Network News

Andrew Florance grew up in Cleveland Park and founded what is now one of the world's largest providers of data on commercial real estate, CoStar Group, in his parents' basement. Twenty-four years later he is still the chief executive, having grown the company into an employer of 1,600 people that monitors real estate transactions in 14 countries, for which subscribers to CoStar pay a premium.

At 48, he is a highly active executive, traveling about 100 days a year and, when the company moved into downtown Washington last year, personally picking through rug patterns, paint colors and other interior details while the company completed interior renovations.

A year or so ago, however, Florance -- a constant and nearly obsessive analyzer of real estate data -- noticed a combination of market dynamics different enough that he considered leaving CoStar and gathering investors to start something new. The "financial disconnect" that Florance says is evident in real estate today may say a lot about how the industry will emerge from the recession. And although Florance opted to remain at CoStar, he did get to put his business scheme to the test.

Just once.

Last week, CoStar agreed to sell its headquarters building at 1331 L St. NW for $101 million, almost $60 million more than it had purchased it for a year earlier. The deal represents the most profitable flip of commercial real estate in Washington and probably the country from the recession to date. The Wall Street Journal said the deal displayed "the breathtaking speed of the market's rebound." It was accentuated by a $6 million tax break D.C. offered Florance to move CoStar from Bethesda, in exchange for which Florance said he has hired dozens of D.C. residents.

And to top it all off, CoStar made its profit without having to leave the building. It is now leasing back the space from the new buyer, GLL Real Estate Partners of Germany.

Florance thinks there is $1 billion in profits available via the same type of transaction that netted him $60 million in 12 months.

What CoStar capitalized on was the disparate effect the recession has had on the value of buildings versus rental rates.

Though hard to believe now, there was a time during the real estate boom when completely empty buildings in hot markets were worth more than those that were partly leased. That's because at a time when rents are rising, a future tenant is more valuable than an existing one. Existing tenants also made it more difficult to attract companies that wanted to consolidate into large spaces and were willing to pay top rents.

When the recession came, that equation was turned upside down. Not only did property values plummet -- nearly 30 percent from their peak in 2007 to their bottom in 2009, according to Green Street Advisors -- but values fell hardest for properties with space available; tenants on existing leases tended to pay more than new tenants capitalizing on the decline.

When Florance started searching for a new headquarters building, considering about 50 in all, this became obvious. "Looking at what people were saying they could rent space to us for, and what I knew I could buy space for, I said, 'Oh my gosh, there's a complete disconnect in the market,' " he said.

As the recovery began a second disconnect emerged, between the values of fully leased buildings and those that were empty or partially leased. For property owners these days, having rent-paying tenants means they have a stable income stream, a valuable commodity if they have mortgages to pay.